Fed Needs to Be More Explicit About Inflation

Via Calculated Risk, James Bullard is hinting that the Fed is going to let inflation slip a bit.

I take that to mean the Fed would support a policy that allowed core inflation to drift above 3% and that tolerated headline inflation of 5%. This is, in my view the right policy. A credible promise to be irresponsible will be key in keeping the American economy out of the doldrums.

However, I’d like to see the Fed be more explicit. I understand not wanting to nail down specific numbers should circumstances change. However, right now much of the public and indeed the financial community believes that the Fed is targeting core inflation at 2%. Failure to meet that perceived target is just as damaging.

Furthermore, increased uncertainty in fixed income markets, as participants try to guess the Fed’s new target is exactly what we don’t need. Setting a hard target and genuinely working to get there will help keep the markets settled.

On the political side there is of course risk. There will be accusations that the Fed is headed towards hyperinflation. I imagine a cable commentator or tow will bring up the Weimar Republic or Zimbabwe.

There is a lot of insane rhetoric floating around about the US either defaulting or attempting to inflate away its debt. Its hard for me to get my head around how otherwise analytically minded people could believe this.

Accepting that, however, the political risk of unexpected inflation is more severe. At the very least a well reasoned case for 5% inoculates you against some of the worst rhetoric – the notion that you have lost control.

“However, right now much of the public and indeed the financial community believes that the Fed is targeting core inflation at 2%. Failure to meet that perceived target is just as damaging….”

Whatever the financial community might believe, “much of the public” would meet the term “inflation target” with a blank stare. They simply don’t know what an inflation target is. They’ve been told for decades that one of the Fed’s most important jobs is to simply fight inflation. In their minds, if inflation is not zero, it’s because even the Money God (formerly, the Money God Greenspan) has to sleep every couple days at least, and maybe take a weekend off per month.

We’ve had so much scare-talk about an inflation-debt bomb already, the public is so primed, that, well … imagine the following congressional testimony:

Congresscritter: “There’s been much talk of debt and deficits re-igniting inflation. What do you think, Mr. Chairman?”

Bernanke: “Holding the line at 3-4% is certainly doable.”

Congresscritter: “But will inflation take off again?”

Bernanke: “Could happen. Any day now, actually. There’s a lot of uncertainty out there.”

Congresscritter: “But what if inflation starts to buck and heave out of control?”

Bernanke: “As you know, we’d need someone with the spine of a Paul Volcker to get it back in the corral. But I’m prepared to yield my saddle to a proven successor, if it becomes necessary. In the meantime, I’ll do what I can.”

Congresscritter: “Do you think getting inflation back down into a reasonable range could be done quickly?”

Bernanke: “So long as it doesn’t exceed 3-4% in the first place? Yes. Hard. Maybe very hard. But doable. Getting it below that range again, though … well …. as I said, there’s a lot of uncertainty out there.”

I know this would mean the unthinkable: a Doctor Bernanke actually whoring himself out to political necessity, in the name of inflation targeting (which he is on record as *theoretically* favoring, at least for Japan.) Maybe he’s just too honest.

But if the Fed and Congress were to have that conversation, what would the public make of it? Your average personal-finance reporter for your average news agency will probably report it as a *prediction*, by the Money God Himself, that 3-4% inflation was in the offing. Because, really, those reporters know as much about macroeconomics and monetary theory as your local TV weather guy knows about paleoclimatology. It won’t much matter if rocket scientists in the financial sector call BS on this “prediction”, so long as there are enough consumers with enough money to fulfill the Money God’s prophecy.

And what have I read about the U.S. GINI index? Last I checked, the GINI indices were saying that the U.S. has too many consumers with far too much money! I say: stick the sap tap into ‘em. Make ‘em think that if they don’t buy a yacht this year, they’ll only be able to afford a slightly shorter yacht next year, that they might get stuck with shorter yachts than their friends have. The shame!

And then that wastrel son of yours who didn’t get a character-building summer job last year might be scraping barnacles off yachts this coming summer. He might have a waiting list of new clients the summer after. He might even have to raise his rates. Which, last I checked, is called a “wage-price spiral.”